Forced marriage

Merger of public sector banks can be tricky

There appears to be a growing consensus among policymakers about greater consolidation in the public sector banking space through mergers. As an idea, it’s nothing new as there have been several rounds of discussions on mergers of state-run banks in India at periodic intervals. But the move has gained momentum of late as many of the public sector banks (PSBs), which together have a 70 per cent market share, are hugely stressed. While Finance Minister Arun Jaitley has said the government will not wait any longer for mergers and has asked the NITI Aayog to give its recommendations on the matter, the Reserve Bank of India is also on board. The key question, however, is whether PSB mergers can solve the problem that the Indian banking sector is facing.

For one, given the trigger, a merger may be an unwise step. To be sure, in the past several experts have suggested mergers among PSBs as an important reform. In particular, a panel led by former RBI governor M Narasimham in 1998 had argued for a three-tier structure for Indian banks: Three large banks with international presence at the top, eight to 10 national banks at tier two, and a large number of regional and local banks at the bottom. But the fact is that both the structure and logic have changed. With more and more private banks providing differentiated services, the banking industry’s demands have changed. More importantly, the recent calls for mergers are being driven by a desire to hide weakness in the form of growing non-performing assets (NPAs) in almost all PSBs. Will merging two banks with significant NPAs on their books help matters? The answer is obvious. 

Part of the reason why mere mergers will not change banks’ performance is that most of the NPAs were accumulated because of the inefficient manner in which PSBs are governed. The P J Nayak committee report, released in 2014, shares the unedifying details. Yet, no substantial change in PSB governance seems to have taken place since then. A merger in the private sector has to contend with checks and balances in the form of shareholders but there is no such luck as far as PSBs are concerned, where the government is the dominant shareholder. Moreover, merger for merger’s sake also overlooks issues of cultural compatibility among banks. Also, employee integration could be tricky, apart from other reported challenges such as provisions for pension liability due to differing employment benefit structures and synchronising accounting policies for recognition of bad loans. That is why share prices of the some of the banks, such as Bank of Baroda, Canara Bank, Vijaya Bank, Dena Bank and Bank of Maharashtra, which are rumoured to be involved in mergers, have dipped.

The policymakers would do well to remember that merging two weak banks, or a relatively strong bank with a weak one, is more likely to make things worse, particularly if the entire process is forced upon the merger candidates. For example, the financial performance of the merged State Bank of India was in stark contrast to standalone SBI’s sterling show in the fourth quarter of the last financial year. This shows simply merging several laggard PSBs with one big profitable one is more likely to hurt the latter.